Demand elasticity and measurement of price elasticity

DEMAND ELASTICITY-CHAITRA.G.R

DEMAND

Demand is an economic principle that describes a consumer's desire and willingness to pay a price for a specific good or service.

Holding all other factors constant, an increase in the price of a good or service will decrease demand, and vice versa.

ELASTICITY

ability to change and adapt

TYPES OF ELASTICITY OF DEMAND PRICE ELASTICITY OF DEMAND INCOME ELASTICITY OF DEMAND CROSS ELASTICITY OF DEMAND PROMOTIONAL ELASTICITY OF

DEMAND

Price elasticity of demand and measurement of price elasticity

Part 1

PRICE ELASTICITY OF DEMANDBy Dr. Marshall 

P.E MAY BE DEFINED AS THE RATIO OF THE PERCENTAGE CHANGE IN THE DEMAND TO THE PERCENTAGE CHANGE IN PRICE.

P.E= %change in quantity demanded/ %change in price

Symbolic representation

Types or degrees of price elasticity Perfectly elastic demand(E=infinity) Perfectly inelastic demand(E=0) Unitary elastic demand (E=1) Elastic demand (E is greater than 1) Inelastic demand (E is less than 1)

1. Perfectly Elastic Demand Perfectly elastic demand is said to

happen when a little change in price leads to an infinite change in quantity demanded. A small rise in price on the part of the seller reduces the demand to zero. In such a case the shape of the demand curve will be horizontal straight line as shown in figure 1.

Perfectly Elastic Demand The figure 1 shows that at

the ruling price OP, the demand is infinite. A slight rise in price will contract the demand to zero. A slight fall in price will attract more consumers but the elasticity of demand will remain infinite (ed=∞). But in real world, the cases of perfectly elastic demand are exceedingly rare and are not of any practical interest.

2. Perfectly Inelastic Demand

Perfectly inelastic demand is opposite to perfectly elastic demand. Under the perfectly inelastic demand, irrespective of any rise or fall in price of a commodity, the quantity demanded remains the same. The elasticity of demand in this case will be equal to zero.

Here (ed = 0).

Perfectly Inelastic Demand

In diagram 2 DD shows the perfectly inelastic demand. At price OP, the quantity demanded is OQ. Now, the price falls to OP1, from OP, the demand remains the same. Similarly, if the price rises to OP2 the demand still remains the same. But just as we do not see the example of perfectly elastic demand in the real world, in the same fashion, it is difficult to come across the cases of perfectly inelastic demand because even the demand for, bare essentials of life does show some degree of responsiveness to change in price.

3. Unitary Elastic Demand:

The demand is said to be unitary elastic when a given proportionate change in the price level brings about an equal proportionate change in quantity demanded. The numerical value of unitary elastic demand is exactly one i.e. Marshall calls it unit elastic.

Unitary Elastic Demand: in figure 3, DD demand

curve represents unitary elastic demand. This demand curve is called rectangular hyperbola. When price is OP, the quantity demanded is OQ\. Now price falls to OP1 the quantity demanded increases to OQ2. The area OQ\RP = area OP\SQ2 in the fig. denotes that in all cases price elasticity of demand is equal to one

4. Relatively Elastic Demand:

Relatively elastic demand refers to a situation in which a small change in price leads to a big change in quantity demanded. In such a case elasticity of demand is said to be more than one (ed > 1). This has been shown in figure 4.

Relatively Elastic Demand In fig. 4, DD is the

demand curve which indicates that when price is OP the quantity demanded is OQ1. Now the price falls from OP to OP1, the quantity demanded increases from OQ1 to OQ2 i.e. quantity demanded changes more than change in price.’

5.Relatively Inelastic Demand:

Under the relatively inelastic demand, a given percentage change in price produces a relatively less percentage change in quantity demanded. In such a case elasticity of demand is said to be less than one (ed < 1). It has been shown in figure 5.

ALL THE FIVE DEGREES REPRESENTATION All the five degrees of

elasticity of demand have been shown in figure 6. On OX axis, quantity demanded and on OY axis price is given.

It shows: 1. AB — Perfectly Inelastic

Demand 2. CD — Perfectly Elastic

Demand 3. EG — Less than Unitary

Elastic Demand 4. EF — Greater Than

Unitary Elastic Demand 5. MN — Unitary Elastic

Demand.

Determinants of price elasticity of demand Availability of substitutes Joint demand Consumer habits Brand Distribution of income Price range Number of uses of the commodity

etc…

Measurement of price elasticity of demand Total Expenditure Method. Proportionate Method. Point Elasticity of Demand. Arc Elasticity of Demand. Revenue Method.

1. Total Expenditure Method Dr. Marshall has evolved the total

expenditure method to measure the price elasticity of demand. According to this method, elasticity of demand can be measured by considering the change in price and the subsequent change in the total quantity of goods purchased and the total amount of money spent on it.

Total Outlay = Price X Quantity Demanded

2. Proportionate Method:

This method is also associated with the name of Dr. Marshall. According to this method, “price elasticity of demand is the ratio of percentage change in the amount demanded to the percentage change in price of the commodity.”

It is also known as the Percentage Method, Flux Method, Ratio Method, and Arithmetic Method. Its formula is as under:

3. Point Method:

This method was also suggested by Marshall and it takes into consideration a straight line demand curve and measures elasticity at different points on the curve. This method has now become very popular method of measuring elasticity.

Point elasticity

4. Arc Elasticity of Demand:

“When elasticity is computed between two separate points on a demand curve, the concept is called Arc elasticity” 

Arc elasticity of demand

5. Revenue Method:

Mrs. Joan Robinson has given this method. She says that elasticity of demand can be measured with the help of average revenue and marginal revenue. Therefore, sale proceeds that a firm obtains by selling its products are called its revenue. However, when total revenue is divided by the number of units sold, we get average revenue.

5. Revenue Method:

On the contrary, when addition is made to the total revenue by the sale of one more unit of the commodity is called marginal revenue. Therefore, the formula to measure elasticity of demand can be written as,

EA = A/ A-M

Where Ed represents elasticity of demand,

A = average revenue and M = marginal revenue